De Grauwe Research Articles

How to conduct monetary policies. The ECB in the past, present and future

We study the evolving operating procedures used by the ECB since its creation. During the period up to 2015, bank reserves were scarce and the ECB, like other central banks, used a corridor system in which the money market rate could fluctuate within the bounds set by the lending and the deposit rates. With the start of Quantitative Easing (QE) the operating procedure evolved into a regime of reserve abundance. This regime has become problematic since the inflation surge forced the central banks to raise the policy rate. The result has been a massive transfer of central banks’ profits (and more) to the banks. We propose a two-tier system of reserve requirements that would only remunerate the reserves in excess of the minimum required. This would drastically reduce the giveaways to banks, allow the central banks to maintain their current operating procedures and make monetary policies more effective in fighting inflation.This paper was presented at the ECB@25 Symposium at Erasmus University, Rotterdam on 16th January 2024. We are grateful to Mary Pieterse-Bloem, Sylvester Eijffinger, Casper de Vries, Charles Goodhart and other participants in the Symposium for comments and suggestions. We also profited from comments and suggestions of an anonymous referee.Previous versions of this paper (De Grauwe and Ji, 2023a, 2023b) profited from comments by Ignazio Angeloni, Peter Bofinger, Robert Holzmann, Pablo Rovira Kaltwasser, Karel Lannoo, Vivien Lévy-Garboua, Anna Lozmann, David Marsh, Wim Moesen, Joachim Nagel, Theo Peeters, Stefan Schmitz, Miklos Vari, and by participants in seminars and presentations at the London School of Economics, King’s College (London), the Bundesbank, the Central Bank of Luxembourg, OMFIF, Sciences Po (Paris), the Austrian National Bank, SUERF, the Polish National Bank and the National Bank of Ukraine.

Explaining the Stylized Facts of Foreign Exchange Markets with a Simple Agent-based Version of Paul de Grauwe’s Chaotic Exchange Rate Model

AbstractWe propose a simple agent-based version of Paul de Grauwe’s chaotic exchange rate model. In particular, we assume that each speculator follows his own technical and fundamental trading rule. Moreover, a speculator’s choice between these two trading philosophies depends on his individual assessment of current market circumstances. Our agent-based model setup is able to explain a number of important stylized facts of foreign exchange markets, including bubbles and crashes, excess volatility, fat-tailed return distributions, serially uncorrelated returns and volatility clustering. A stability and bifurcation analysis of its deterministic skeleton provides us with useful insights that foster our understanding of exchange rate dynamics.

Türkiye From The Perspective of the Theory of Pillarization

The Netherlands has had a rich theoretical array of instruments to view and understand societal matters. One of the first theoretical instruments is ‘pillarization’ also called verzuiling (Van Doorn 1956) in the Dutch language. A second theoretical instruments is ‘consociationalism’ that was developed by Arend Lijphart (Lijphart 2008) applying the idea of pillarization to all societies in a generic sense. Then a third related concept in this array of theories is ‘corporatism’ (De Grauwe 1977) that has had a strong influence in the Dutch political culture. All three concepts are characteristic for the Dutch political historical development. Although they may sometimes be used interchangeably, all three concepts are interrelated but not the same (Wintle 2000). All three instruments have played important roles in the social-historical processes in the emancipation of minority groups and in the building of a national identity (Miert 1992). The three concepts consociation, pillarization and corporatism have been important in public life. This article views all three concepts by viewing the Dutch history and looks into the Turkish socio-political processes today. The argumentation of this paper is that at least two of three concepts will apply to the Turkish public, political life and culture. I argue that the Turkish situation can also be characterised by the concept of vertical pluralism that was followed by a reversed process called depillarization (ontzuiling) in the Dutch language. This depillarization efforts can be seen in the way political parties seek coalition and consensus in multiple forms as is the case with the Cumhur ittifakı and the six partner formations (altılı masa formasyonu).

Revisiting Paul de Grauwe’s Chaotic Exchange Rate Model: New Analytical Insights and Agent-Based Explorations

We apply recent stability and bifurcation results to provide an analytical characterization of Paul de Grauwe’s chaotic exchange rate model. We prove that the model’s fundamental steady state becomes unstable due to a Neimark-Sacker bifurcation when chartists extrapolate past exchange rate trends too strongly, a phenomenon that gives rise to cyclical exchange rate dynamics. In contrast, fundamentalists’ mean reversion strength only has a stabilizing effect on the model’s dynamics when the exchange rate is out of equilibrium. We also show that agent-based versions of Paul de Grauwe’s exchange rate model may produce endogenous exchange rate dynamics, too.

China’s bilateral trade in Africa: is institutional structure a determinant?

PurposeThe purpose of this paper is to empirically examine the institutional structures and other predictors that determine bilateral trade between Africa and China from 1995 to 2017.Design/methodology/approachIn line with the gravity model of trade, institutional, geographical and socio-economic determinants of China’s bilateral trade with 18 African oil/minerals exporting countries are examined by deploying Poisson pseudo-maximum likelihood and dynamic bias-corrected least squares dummy variable econometric techniques.FindingsThe results indicate that China’s oil/minerals imports from Africa are higher than imports of manufacturing and agricultural goods, and institutional structures indicate that a weak politically stable region with less control of corruption has a discernible effect on trade.Research limitations/implicationsFurther insight can be gained if the type of manufactured goods being exported to China is examined; this is necessary given that China crowds out Africa’s manufactured goods. Therefore, this study recommends the need for Africa to continually strengthen its institutional structures to stimulate trade from other regions.Originality/valueThis study examines the quality of the institutional structures (political stability and corruption) in African oil/minerals exporting countries, considering that China has been alleged for capitalising on Africa’s weak institutional structures to trade with the resource-endowed region. For the first time, the UN COMTRADE HS product-country-partner-year trade data is used to examine on bilateral sector trade China–Africa links rather than proxies used in the studies of Biggeri and Sanfilippo (2009), De Grauwe et al. (2012) and Foad (2011) that did not capture the real trade value.

Book Reviews

Tiziana Assenza of Toulouse School of Economics, University of Toulouse Capitole reviews “Behavioural Macroeconomics: Theory and Policy” by Paul De Grauwe and Yuemei Ji. The Econlit abstract of this book begins: “Presents new theoretical macroeconomic models based on individuals' complexity, heterogeneity, and cognitive limitations, addressing the current implausible assumptions of mainstream macroeconomics about human behavior and the capacity of human beings to comprehend the world they live in.”

Bridge over Troubled Monetary Union: A Reply to De Grauwe & Ji

Bridge over Troubled Monetary Union: A Reply to De Grauwe & Ji

Animal spirits in an open economy: an interaction-based approach to the business cycle

Abstract This paper examines the effects of boundedly rational expectation on the business cycle in a two-country New Keynesian model. Forecast heuristics in a closed-economy, De Grauwe’s (2011) model, is extended, and the effects of heterogeneous agents are incorporated in an open economy. In particular, the expectation formation process is constrained by waves of optimists and pessimists – the so-called “animal spirits.” As a result, the model is able to explain group behavior based on forecast performance, which has significant effects on output and inflation dynamics in the two countries. The simulation results suggest that heterogeneity in group behavior and nominal rigidities, as well as a moderate degree of international trade, amplify spillover effects on international business cycles leading to high cross-correlations in output and inflation.

The importance of being earnest

PurposeThis paper aims to provide an empirical analysis of the macroeconomic determinants of sovereign bond yield spreads in the Eurozone from 2000 until August 2012, when the Outright Monetary Transactions programme was launched.Design/methodology/approachThe authors constructed an unbalanced panel with quarterly data from 2000 Q1 to 2012 Q2 for the 12 Eurozone countries: Austria, Belgium, Finland, France, Germany, Greece, Ireland, Luxembourg, Italy, The Netherlands, Portugal and Spain. The authors propose a model that explains spreads through the main categories of variables observed in the literature. The relationship between variables is analysed using ordinary least squares and quantile regressions. As discussed by the authors, quantile regressions provide a more precise estimation, given the huge heterogeneity across counties that can be observed in the Eurozone.FindingsResults show that the relationship between sovereign risk and macroeconomic fundamentals is affected by a strong country sentiment effect. The impact of country sentiment on sovereign risk is larger for those countries that were already experiencing higher spreads. Regardless the impact that European Central Bank’s (ECB) intervention had on sovereign risk from 2012, quantile regression results suggest that policy recommendations and goals should be adapted to each country’s market perception.Originality/valueThe results obtained improve on previous findings on this topic (De Grauwe and Ji, 2012) in two ways. First, they show that even introducing every category of determinants found in the literature in the main specification, fundamentals can only partially explain the evolution of sovereign risk in the Eurozone. Second, they find there is a country-sentiment effect that affects the relationship between macroeconomic indicators and sovereign risk. Furthermore, the paper finds that the country-sentiment effect is larger for countries facing high spreads.

The role of cognitive limitations and heterogeneous expectations for aggregate production and credit cycle

The behavioural model of De Grauwe and Macchiarelli (2015) is extended to include financial frictions on the (aggregate) supply side. The result is a tight and sustained feedback loop between animal spirits on one hand, and supply of credit, capital purchase and production on the other. During phases of optimism, credit is abundant, access to production capital is easy, the cash-in-advance constraint is lax, risks are undervalued, and production is booming. Upon reversal in market sentiment, the contraction is quick and deep. Moreover, the model is capable of replicating the stylized fact of a long and sustained simultaneous growth in credit, production and asset prices observed in the US since mid1990’s. Lastly, the behavioural model does a decent job in matching US data including multiple supply-side relations including capital-firm credit and inflation-interest rate.

The financial crisis in the eurozone: a balance-of-payments crisis with a single currency?

In a pegged exchange-rate system, a balance-of-payments crisis happens when there is serious mistrust of whether a debtor country holds sufficient international reserves to monetise a capital withdrawal at the ongoing exchange-rate parity. In the eurozone (EZ), doubts that banks and governments of peripheral countries could settle debts when they matured led to a massive capital outflow after the fall of Lehman Brothers and, especially, the first Greek sovereign-debt crisis. This has led some authors to hold that the situation in the EZ is a balance-of-payments (BoP) crisis.However, the European Central Bank (ECB) offset massive financial capital withdrawals with a huge inflow of reserves to the EZ periphery, making the international reserves constraint irrelevant. This invalidated the BoP view in other authors’ opinion, who pointed out bad bank behaviour and a poor initial institutional design as the alternative root cause for the current mess. This position is known as the monetary sovereign (MS) view.In this paper, we provide a brief overview of the debate between both sides, with Cesaratto, as a representative for the BoP view, and Lavoie, De Grauwe and Wray, for the MS view, and discuss whether a reconciliation between these two positions can be possible. We step into the discussion to offer two additional arguments in favour of the second view: (i) A currency union requires a single monetary policy, as opposed to a fixed exchange-rate regime; TARGET2 balances combined with refinancing operations are an essential ingredient of monetary policy implementation. (ii) The current situation is more easily understood as another episode of financial instability after banks have granted huge amounts of credit (which they refinanced abroad). The situation got even worse because governments supporting troubled banks in their respective jurisdictions lacked a lender of last resort.

The Limits of the Market: The Pendulum between Government and Market, by PaulDe Grauwe (Oxford University Press, Oxford, 2017), 192 pp.

Economic RecordVolume 93, Issue 303 p. 653-655 Review The Limits of the Market: The Pendulum between Government and Market, by Paul De Grauwe ( Oxford University Press, Oxford, 2017), 192 pp. Syed Basher, Syed Basher East West University, Dhaka, BangladeshSearch for more papers by this author Syed Basher, Syed Basher East West University, Dhaka, BangladeshSearch for more papers by this author First published: 04 December 2017 https://doi.org/10.1111/1475-4932.12375Read the full textAboutPDF ToolsRequest permissionExport citationAdd to favoritesTrack citation ShareShare Give accessShare full text accessShare full-text accessPlease review our Terms and Conditions of Use and check box below to share full-text version of article.I have read and accept the Wiley Online Library Terms and Conditions of UseShareable LinkUse the link below to share a full-text version of this article with your friends and colleagues. Learn more.Copy URL Share a linkShare onFacebookTwitterLinkedInRedditWechat No abstract is available for this article. Volume93, Issue303December 2017Pages 653-655 RelatedInformation

Exploring the Capacity of Formal School Governing Bodies in Rural Ghana: The Case of Effutu Municipality

<p><em>As part of wider social and democratic governance reforms, the Government of Ghana embarked on a process of education decentralization in 1987 (GOG, 1996). The central focus of this policy was the prescription of community participation in the affairs of school in each locality (Essuman & Akyeampong, 2011). Free Compulsory Universal Basic Education (FCUBE) policy recommends the formation of School Management Committees (SMCs), governing bodies and Parent-Teacher Associations (PTAs) by individual schools to work hand-in-hand with the head teacher and guide him/her in school policy formulation (GES, 2001). Capacity has become a topical issue in decentralisation discourse and critics of the latter have argued against the lack of technical and human resource availability at the local level (De Grauwe et al., 2005; Robinson, 2007), but unfortunately, research on capacity of formal governance bodies appears to have been less undertaken in poorer rural areas in Ghana. In recognition of this, the study sought to understand the nature and quality of capacity and how that impact on participation in school from the perspectives of SMCs in two rural school communities in Effutu Municipality. The study adopted qualitative methods of focus groups, supported by some initial documentary analysis to gain understanding of school governance from key stakeholder perspectives. The findings revealed that although formal school governing bodies existed in the rural study communities, many of the SMC members lacked human and material resource to engage fully in school management. The study recommends capacity building and training programmes to enable the SMC members upgrade their knowledge and skills in school governance.</em></p>

Stabilizing Valences of an Optimum Monetary Zone in a Resilient Economy—Approaches and Limitations

Following De Grauwe (2016), this research advances the idea according to which economies that are part of a monetary union issue debt in a medium of exchange they cannot control: financial markets develop the capacity to impose default on such economies. We are interested in how previous research analyzed the notion that, when economies are autonomous and they employ the exchange rate as a vehicle to handle asymmetric shocks, they confront comparable constraints on the performance of exchange rate strategies. When a monetary union is affected by significant asymmetric shocks, the member economies have to deal with tough adjustment issues. Empirical and secondary data are used to back the assertion that, in a monetary union, economies that are affected by long-lasting asymmetric demand shocks demand wage elasticity and labor flexibility to rectify for them, and if the latter generate substantial budget deficits, financial markets tend to intensify the consequences of the asymmetric shocks, boosting the demand for severe regulation of wages and labor flexibility. Our article makes conceptual and methodological contributions to the view that member economies of a monetary union are exposed to varying market reactions, generating more volatility in the business cycle: an economy undergoing a recession and a rise in the budget deficit might be affected by wide-ranging transactions of its government bonds, causing a liquidity crisis and superior interest rates, and possibly coercing the government of that economy to adopt budgetary austerity measures, thus intensifying the recession.

Monetary transmission under competing corporate finance regimes

The behavioral agent-based framework of De Grauwe and Gerba (2015) is extended to allow for a counterfactual exercise on the role of corporate finance arrangements for monetary transmission. Two alternative firm financial frictions are independently introduced: market-based and bank-based. We find convincing evidence that the overall monetary transmission channel is stronger in the bank-based system compared to the market-based. While the growth in credit is larger in the market-based system, uncertainty originated from imperfect beliefs produce impulse responses in macroeconomic variables that are, on average, half of those in the bank-based model. At the same time we find mixed results on the conditional effectiveness of monetary policy to offset contractions. Conditional on being in a recession, a monetary expansion in a market-based system creates higher successive booms. That said, a monetary easing in the bank-based system is more effective in smoothening the financial-and business cycles.

Bayesian estimation of agent-based models

We consider Bayesian inference techniques for agent-based (AB) models, as an alternative to simulated minimum distance (SMD). Three computationally heavy steps are involved: (i) simulating the model, (ii) estimating the likelihood and (iii) sampling from the posterior distribution of the parameters. Computational complexity of AB models implies that efficient techniques have to be used with respect to points (ii) and (iii), possibly involving approximations. We first discuss non-parametric (kernel density) estimation of the likelihood, coupled with Markov chain Monte Carlo sampling schemes. We then turn to parametric approximations of the likelihood, which can be derived by observing the distribution of the simulation outcomes around the statistical equilibria, or by assuming a specific form for the distribution of external deviations in the data. Finally, we introduce Approximate Bayesian Computation techniques for likelihood-free estimation. These allow embedding SMD methods in a Bayesian framework, and are particularly suited when robust estimation is needed. These techniques are first tested in a simple price discovery model with one parameter, and then employed to estimate the behavioural macroeconomic model of De Grauwe (2012), with nine unknown parameters.

The Impact of the Tobin Tax in a Heterogeneous Agent Model of the Foreign Exchange Market

We explore possible effects of a Tobin tax on exchange rate dynamics in a heterogeneous agent model. To assess the impact of the Tobin tax in this framework, we extend the model of De Grauwe and Grimaldi (Eur Econ Rev 50(1):1–33, 2006) by including transaction costs and perform numerical simulations. Motivated by the importance of the market microstructure, we choose to model the market as being cleared by a Walrasian auctioneer. This setting could more closely resemble the two-layered structure of foreign exchanges at daily frequency than a price impact function, which is often adopted in similar studies. We find that the Tobin tax can deliver a moderate reduction of return volatility and kurtosis. In addition, simulations indicate that the Tobin tax reduces the degree of mispricing in the time series, which is primarily achieved by eliminating long-lasting deviations from fundamental value.

A comment on De Grauwe's, “The legacy of the Eurozone crisis and how to overcome it”

Abstract De Grauwe (2016) argues that it has been the asymmetric economic policies of the European Commission where credit nations have benefited at the expense of debtor nations that have fueled the Euro Crisis. In this short comment I provide an alternative explanation for the amplification and persistence experienced by the Eurozone economy during the double-dip recessions of 2008 to 2009 and 2011 to 2013. The Euro crisis can be traced back to contractionary monetary policies made by the European Central Bank at a time when the Eurozone required expansionary monetary policy.

The Rise of China and Regional Integration in East Asia

Over the past decades, East Asia has achieved one of the most profound economic transformations in recorded history, and has become the most dynamic economic region and one of the most integrated areas in the world. However, regional and economic integration in East Asia is a relatively new phenomenon and cooperation is lightly institutionalized (ADB, 2008). Largely reflecting the diversity of the economies, the East Asian regionalism follows a markedly different pattern from that in Europe and other regions. In the absence of a formal institutional framework, the regional integration in East Asia has been driven by market forces and by the development of increasingly sophisticated production sharing and intra‐regional network trade, in which China's rapid growth has been instrumental. It is the international firms that are creating linkages across borders in their search for profitable opportunities through trade, foreign direct investment (FDI), and other arrangements in accordance with changes in comparative advantage, industrial upgrading, and unilateral liberalization of goods and capital markets in the region (Dobson, 1997; Zhang, 2003; De Grauwe and Zhang, 2012). Policies such as preferential trading arrangements have traditionally not played much of a role in the integration of the region.

Interdisciplinary Analysis of Luhmann’s Sociological Theory on the Euro-Crisis

ABSTRACT. This paper establishes a unique linkage between economic and sociological theories. I study the root causes of the euro crisis from both perspectives. I find that resolving the euro crisis requires economic and sociological insights, particularly in respect to the design of European institutions, rules, and regulations. I develop a new paradigm in attempt to tackle the euro crisis. This paper demonstrates the importance of an interdisciplinary dialogue and how this may safeguard the future of the Economic and Monetary Union.Keywords: Euro-Crisis, Luhmann's Social Systems Theory, Economics.JEL Classification : G12; E65; C58IntroductionThe ongoing 'euro crisis' is often seen as an economic issue and referred to as the European sovereign debt crisis. Admittedly, a comprehensive economic analysis demonstrates that the euro crisis has several origins and is not just a simple debt crisis (Lane, 2012). There are multiple root causes and vulnerabilities, particularly the flawed European economic and fiscal governance (Herzog, 2013). However, as I establish in this paper, the euro crisis has a firm sociological underpinning at the same time. According to Luhmann's 'Social Systems Theory', there is a fundamental problem in functional systems, such as in the Economic and Monetary Union (EMU). In other words, Europe is facing a social-systems problem rather than just an economic crisis. This insight is intuitive under the recognition that the euro crisis is not merely a macroeconomic and monetary issue, and thus, as I will show, relates also to flawed functional systems as studied in sociology.The fundamental dynamics of states, institutions, and humans is predisposed to both group interactions and incentives. Sociological theory studies those group patterns and behaviours and thus do have an impact to resolve the euro crisis in the real world. Economic theory on the other hand lacks a rigorous discussion of group interactions because this is too sophisticated to be subsumed under the assumption of the methodological individualism a la Max Weber (1929).I find that Luhmann's approach precisely reveals this insight, especially in respect to the systemic effects of the macro-economy. The constructivist idea demonstrates - the repeatedly unconnected - linkages between the institutional (legal), economic, and political system. Thus, this interdisciplinary study of the economic and sociological origins of the European sovereign debt crisis appears promising. Indeed any policy recommendation, which tackles the existing flaws in fiscal and economic governance in Europe, requires a thorough understanding of both spheres.Section 2 starts with the economic analysis of the root causes and implications. In section 3, I utilize Luhmann's social systems theory to obtain a new perspective on the euro crisis. Finally, I compare insights and implications of both scientific perspectives, and summarize the policy recommendations in section 4. Section 5 concludes the paper.1. Economic PerspectiveTo make this paper comprehensible to an interdisciplinary community, I shall briefly explain the necessary economic theory and mainstream arguments about the root causes of the euro crisis in this section. There are already excellent overview articles on the economic root causes by Lane (2012), Arghyrou and Kontonikas (2012), Sachverstandigenrat (2012), De Grauwe and Ji (2013) and Geithner (2014).There is no doubt that the Economic and Monetary Union (EMU) has been in an economic and political crisis since 2010. The first fundamental problem is the current account imbalance across the macro-economy of the euro area member states (Herzog, 2012).Secondly the European institutional structure is unsuitable to tackle this issue. There is a consensus that fiscal and economic governance is a prerequisite for a successful and effective monetary union (Escolano et al., 2012) and this has been identified in economic literature long ago (Beetsma and Bovernberg, 1999; Beetsma and Uhlig, 1999). …